Infrastructure needs a stronger foundation

March 21 2003

NSW reaps the highest taxes in the country - so it should begin ploughing more back into essential areas, writes John Garnaut.

Our tireless state Treasurer, Michael Egan, has worked so hard for the past eight years there is nothing left to do. All the fundamental economic reforms are done, he told journalists recently, and now it was just a matter of "preventing backsliding".

Mr Egan and the Premier, Bob Carr, have ironed out some of the worst inefficiencies in the provision of gas, water and electricity. They have also retired $8billion in government debt.

But there is a long list of reforms to ensure the state's future prosperity. Cleaning up the tax system, lifting investment in infrastructure and fixing federal-state funding arrangements would be good places to start.

Under the Carr Government, NSW has become the country's highest taxing state. And those taxes remain a tangled, unfair and inefficient mess.

An efficient tax, in economic terms, is one that does not distort spending and investment decisions. Chris Richardson of Access Economics says stamp duty is one of the most inefficient taxes of all, as it acts as a barrier to people moving to preferred locations and trading goods they no longer want. He estimates every dollar raised by stamp duty costs the economy 79 cents in lost activity, a so-called deadweight loss. Yet stamp duty has risen by 48 per cent in the past four years to account for 37 per cent of the state's tax take.

Poor victims

NSW also relies heavily on some taxes that are efficient but regressive, in that they hit poor people disproportionately.

Gambling taxes, which account for about 8 per cent of state tax revenue, are supposed to discourage problem gamblers from gambling. In reality, says John Quiggin, a professor of economics at the University of Queensland, they merely compound a gambler's losses.

"What the Government does in taxing gambling is stack the odds even further against gamblers, leading to them losing even more money."

A more efficient and equitable tax system would reduce the reliance on stamp duty and gambling taxes, and put more emphasis on "wealth" taxes. One option would be to continue ending exemptions to land tax so they apply to more residential homes, while phasing out stamp duties.

If the states acted in concert and agreed to eliminate the most unfair and inefficient taxes, they could then move to reinstate death duties, one of the most equitable and efficient taxes, or ask the Federal Government to lift the rate of GST.

It would take considerable political courage to reform the state tax system, but there are few reform tasks that could offer more economic and equitable rewards.

The other side of this budgetary coin is whether NSW's spending is appropriate, both in its extent and in the balance between spending on services and infrastructure. Mr Richardson says NSW has blown "an awful lot" of its revenue windfalls on recurrent spending, like wages, but has neglected transport, utilities and telecommunications.

"In Sydney it's a problem now - they haven't had the guts to buy up some land, push through some roads ... and free up the arteries of transport."

The Government's claim that Sydney is "full" is, he says, partly an admission of inadequate investment in infrastructure.

Investment failure

Bob Walker, a professor of accounting at the University of NSW, says successive governments have failed to invest in maintaining infrastructure - until disasters occur, such as the Waterfall train crash or the 1998 water contamination crisis.

The latest Infrastructure Report Card compiled by the Institute of Engineers shows the nation's railways, local roads, irrigation and stormwater networks are "in a disturbing state".

NSW is singled out for criticism. The report laments the postponement of fast-rail links to Wollongong and Newcastle, says Sydney's commuter rail system is a "critical bottleneck" to the nation's freight railways and says a small amount of investment now could avert "potentially enormous costs" in reviving defunct railways in the future.

Professor Walker says state governments should have to report on maintenance requirements for existing infrastructure. Such a program is being tested at local government level.

Christopher Sheil, a research fellow at UNSW, blames the Government's "idiotic" no-debt policy. He says debt phobia has led to low investment, which deprives future generations of the social and economic benefits of solid infrastructure.

The private sector borrows funds to invest in the future, and so should governments. The Commonwealth takes GST and other national tax revenue and distributes it in tied and general grants to the states. NSW has traditionally been penalised by the system, which partly explains why its state tax take is so high and infrastructure spending so low.

Each person in NSW paid $1383 in GST to the Commonwealth last financial year, on average, but received only $1117 of grants in return. No other state received a lower proportion of the GST it contributed.

A simple mess

The Commonwealth's provision of GST revenues to the states was supposed to simplify the grants system but it has not worked.

The Review of Commonwealth State Funding, commissioned by NSW, Victoria and Western Australia, shows fiscal equalisation, the ostensible rationale behind the system, and has no effect on reducing inequality.

Only 31 per cent of State Government revenue was raised through its own taxes last financial year, amounting to $12.6 billion, compared with 36 per cent in handouts from the Federal Government.

Professor Quiggin says this "vertical fiscal imbalance" makes the State Government electorally unaccountable for a large chunk of the money it raises and blurs responsibility for money it spends. Whether it is drought relief, education or health, Sydney blames Canberra when things go wrong and Canberra blames Sydney.

Federal-state relations is an ugly knot that has been growing and calcifying since Federation. It would take a heroic act of statesmanship to cut a deal with the states and the Commonwealth and begin untangling it.

Contrary to Mr Egan's remarks, there is an enormous amount of work for an ambitious and visionary treasurer. For the sake of the state's future welfare, the next treasurer should be willing to gamble his or her reputation on switching spending priorities from services to infrastructure, reforming the tax system and cutting a better deal for NSW, and Australia, under the Commonwealth Grants system.